chap 2

Question 1

Securities Markets:

Answer 1

markets that allow buyers and sellers of securities to make financial transactions

Question 2

Money market:

Answer 2

the market where short-term debt securities are bought and sold

Question 3

Capital Market

Answer 3

the market where long-term securities, such as stocks and bonds, are bought and sold; classified as primary or secondary.

Question 4

Securities and Exchange Commission (SEC):

Answer 4

Federal agency that regulates the securities markets.

Question 5

Primary market:

Answer 5

the market in which new issues of securities are sold to investors

Question 6

Initial Public Offering (IPO):

Answer 6

the first public sale of a company’s stock

Question 7

Public offering:

Answer 7

securities offered for sale to public investors

Question 8

Rights offering:

Answer 8

shares are offered to existing shareholders on a pro rata basis

Question 9

Private placement:

Answer 9

securities sold directly to select groups of private investors

Question 10

Underwriting:

Answer 10

promoting the stock and facilitating the sale of the company’s shares.

Question 11

Prospectus:

Answer 11

registration statement describing the issue and the issuer

Question 12

Quiet period:

Answer 12

time period after prospectus is filed when company must restrict what is said about the company

Question 13

Red Herring:

Answer 13

preliminary prospectus available during the waiting period

Question 14

Road show:

Answer 14

series of presentations to potential investors

Question 15

Investment Banker:

Answer 15

Financial intermediary that specializes in assisting companies in issuing new securities and advising firms with regard to major financial transactions

Question 16

Underwriting

Answer 16

purchases the security at agreed-upon price and bears risk of selling it to the public.

Question 17

Underwriting Syndicate:

Answer 17

group formed to share the financial risk of underwriting

Question 18

Selling group:

Answer 18

other brokerage firms that help the underwriting syndicate sell the issue to the public

Question 19

Secondary market (aftermarket):

Answer 19

the market in which securities are traded after they have been issued

Question 20

National Securities Exchanges:

Answer 20

markets in which the buyers and sellers of listed securities come together to execute trades.

Question 21

Over-the-counter (OTC) Market:

Answer 21

Involves trading in smaller, unlisted securities

Question 22

Broker Market:

Answer 22

consists of national and regional securities exchanges. Trades are executed when a buyer and a seller are brought together by a brokerand the trade takes place directly between the buyer and seller

Question 23

Dealer Market:

Answer 23

made up of the Nasdaq OMX and OTC trading venues. Trades are executed with a dealer (market maker) in the middle.

Sellers sell to a market maker at a stated price.

The market maker then offers the securities to a buyer

Question 24

Designated market maker (DMM):

Answer 24

an exchange member who specializes in making transactions in one or more stocks ; job is to manage the auction process

Question 25

Regional Stock Exchanges

Answer 25

Modeled after the NYSE, but membership and listing requirements are more lenient. –Majority of securities listed here are also listed on NYSE

Question 26

Broker Markets: what types of exchange happen ?

Answer 26

Options Exchanges –Allows trading of options –Dominant exchange is Chicago Board Options Exchange (CBOE) Futures Exchanges –Allows trading of futures –Dominant exchange is the CME Group

Question 27

Bid price:

Answer 27

the highest price offered to purchase a given security

Question 28

Ask price:

Answer 28

the lowest price offered to sell a given security.

Question 29

The Over-the-Counter Market (dealer market)

Answer 29

Includes mostly smaller companies that either cannot or do not wish to comply with Nasdaq’s listing requirements. –Companies traded on the OTC Bulletin Board (OTCBB) are regulated and required to file audited financial statements and comply with federal securities law. –Companies traded on the OTC Markets Group are not required to file with the SEC

Question 30

OTC Markets Groups:

Answer 30

OTC Pink: unregulated; small, risky companies * OTC QB: companies must provide SEC, bank, or insurance reporting and be current in their disclosures. * OTC QX: reserved for companies that choose to provide audited financial statements and other required information

Question 31

Third market

Answer 31

consists of over-the-counter transactions made in securities listed on the NYSE or one of the other exchanges Large institutional investors go through market makers that are not members of a securities exchange Institutional investors (mutual funds, life insurance companies, pension funds) receive reduced trading costs due to large size of transactions

Question 32

Fourth Market

Answer 32

consists of transactions made through a computer network, rather than on an exchange, directly between large institutional buyers and sellers of securities. Electronic communications networks (ECNs) allow direct trading. –Most effective for high-volume, actively traded securities and play a key role in after-hours trading. –Can save money because they only charge a transaction fee, per share or based on order size.

Question 33

Bull market:

Answer 33

Conditions in security markets normally associated with rising prices, investor optimism, economic recovery, and government stimulus

Question 34

Bear Market:

Answer 34

Conditions in security markets normally associated with falling prices, investor pessimism, economic slowdown, and government restraint

Question 35

Long purchase:

Answer 35

transaction in which investors buy securities, usually in the hope they will increase in value and can be sold at a later date for profit. –Object is to “buy low and sell high” –Most common type of transaction –Return comes from any dividends or interest received during the ownership period, plus the difference (capital gain or loss) between the purchase and selling prices. Reduced by transaction costs

Question 36

Margin trading:

Answer 36

Investors use funds borrowed from brokerage firms to make securities purchases.

Question 37

Margin requirement:(for margin trading)

Answer 37

the minimum amount of equity that must be in the margin investor’s own funds. The margin requirement for stocks has been 50% for some time; set by the Federal Reserve Board.

Question 38

Financial leverage:

Answer 38

the use of debt financing to magnify investment returns

Question 39

Margin loan:

Answer 39

official vehicle through which the borrowed funds are made available in a margin transaction

Question 40

Advantages of Margin trading

Answer 40

Magnifies returns –Allows investors to spread their limited capital over a larger number of investments which promotes diversification

Question 41

Disadvantages of Margin trading

Answer 41

Magnifies losses –Cost of margin loan: the vehicle through which the borrowed funds are made available •Interest rate usually 1% to 3% above the prime rate:the interest rate charged to creditworthy business borrowers

Question 42

Margin account:

Answer 42

established to execute a margin transaction, an investor must contribute a minimum of $2,000 in equity or 100% of the purchase price, whichever is less, in the form of cash or securities.

Question 43

Initial margin:

Answer 43

minimum amount of equity that must be provided by the investor

Question 44

Restricted account:

Answer 44

account with equity less than the initial margin requirement

Question 45

Maintenance margin:

Answer 45

absolute minimum amount of margin (equity) that an investor must maintain in the margin account at all times

Question 46

Margin call:

Answer 46

Investor receives this when an insufficient amount of maintenance margin exists and then has a short period of time (few hour to few days) to bring equity up above the maintenance margin

Question 47

Debit balance:

Answer 47

amount of money being borrowed in the margin loan

Question 48

Uses of Margin Trading

Answer 48

Magnify returns Pyramiding: uses the paper profits in margin accounts to partly or fully finance the acquisition of additional securities.

Question 49

Excess margin:

Answer 49

more equity in the account than required –Constraint: when additional securities are purchased your margin account must be at or above the required initial margin level. –Risk associated with possible price declines in the margined securities

Question 50

Short selling:

Answer 50

practice of selling borrowed securitiesInvestor borrows securities from a broker Broker lends securities owned by other investors that are held in “street name” Investor must make a deposit with the broker equal to the initial margin requirement applied to short-sale proceeds; broker retains proceeds from the short sale. “Sell high and buy low” Investors make money when stock prices go down

Question 51

Advantages and disadvantages of short selling

Answer 51

Advantages Chance to profit when stock price declines– Disadvantages Limited return opportunities: stock price cannot go below $0.00 Unlimited risks: stock price can go up an unlimited amount If stock price goes up, short seller still needs to buy shares to pay back the “borrowed” shares to the broker Short sellers never earn dividend income and must pay to the lender any dividends paid out during the short-sale transaction